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SCOREBOARD: Patience, grasshopper

Extending Operation Twist doesn't mean the Fed has changed its outlook, or that QE3 is out, despite Wall Street's disappointment.

As expected, helicopter Ben opted to extend operation twist, taking advantage of a minor softening in data to make the case that the recovery was threatened and required more stimulus. "Specifically, the committee intends to purchase Treasury securities with remaining maturities of six years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately three years or less”.

Make no mistake: there has been no real change to US growth prospects which remain excellent. US jobs are being created at close to maximum speed (given current capacity constraints) and inflation is at or above target. Private demand remains strong etc. This hasn’t changed because of a temporary and perfectly normal lull in the data. It’s what the data does. You can probably get a sense of that from the FOMC’s forecasts.

Members of the Federal Reserve board have certainly revised down their growth, employment and inflation forecasts – but marginally overall. Growth is now expected in the lower half of the 2-3 per cent range (specifically growth of between 1.9 and 2.4 per cent), from the upper half in April (from 2.4 and 2.9 per cent). At this early stage that is a meaningless forecast – it’s a slight tinkering and what the Fed is saying is that in April they were expecting trend growth, but now they reckon growth will be a little below trend. It’s not a material change. Core inflation forecasts were barely changed at all – to 1.7-2 per cent now from 1.8-2 per cent previously.

So again, it’s not that the Fed had some massive change in its outlook and thought ‘wow, we need more stimulus’. The absence of any material change in their outlook suggests that the decision to extend operation twist was predetermined – and this is a common view. All through the year I and others have been highlighting that it would be best to just assume that some derivation of QE3 would likely follow this round of operation twist – regardless of the economic data flow. It’s all about keeping the national interest bill (and the US dollar) well down – issuing debt at the highest possible price (lowest yield). And it is working.

That may not have looked to be the case last night – US yields actually rose a couple of basis points to 1.65 per cent on the 10-year, 0.75 per cent on the 5-year and even the 2-year yield rose to 0.32 per cent. But this is small fry and in any case, bonds actually did push higher initially and the 10-year yield dropped 5bps to a low yield of about 1.62 per cent.

Unfortunately US equity markets didn’t seem all that enthused. Perhaps because they wanted more – full blown QE. Patience – it is still more likely than not that this will come. Ben doesn’t know anything different and the US has bills to pay. What are they going to do at the end of the year? All of a sudden decide to start paying interest? I doubt it. Anyhow, the S&P500 finished 0.2 per cent lower (1355), with the Nasdaq and Dow off 0.1 per cent (2926 and 12824). As for the SPI, it looks to have outperformed, rising 0.4 per cent (4144).

European stocks actually had a better session of it – with the Dax up 0.5 per cent, CaC up 0.3 per cent and FTSE up 0.6 per cent. But then they didn’t have to deal with the lies of the Bernank. Instead, we saw the Greeks form a government (new Democracy got that coalition with Pasok and the Democratic left), who, with the firm knowledge that 80 per cent of the population wish to stay in the eurozone, know they have a popular mandate to continue reform. A huge, overwhelming majority support this. Similarly, there was more noise overnight that the European bailout funds might be used to buy Spanish and Italian debt. So we saw another fall in yields here – with the Spanish 10-year yield falling around 15 bps to 6.73 per cent, while Italy’s 10-year was down about the same to 5.75 per cent. This, by the by, is also why US Treasuries sold off into the close, reversing some of that post Bernanke rally. I still don’t have a strong sense as to how much traction the idea has though – reports are still conflicting.

Price action elsewhere saw the Australian dollar hit a peak of about $US1.022 before easing off to $US1.0191 currently (little changed from yesterday afternoon). The euro (1.2707) also got whipped around by the Fed, but settled 20 pips or so higher than at 1630 AEST yesterday. Sterling is then at $1.5718 and yen at $79.52. As for commodities? Well, New York trading saw gold down about $10 ($1607), despite news that Chinese physical for gold is at new records. Crude then fell 2.7 per cent to $81, which the lowest price since October 2011, on a report suggesting US oil inventories are their highest since 1990. Copper was off then 1.5 per cent.

There wasn’t really much in the way of other data out. German producer prices rose 0.1 per cent in May to be 2.1 per cent higher annually. The in the UK, employment rose by 166,000 in the three months to April and the unemployment rate was steady at 8.2 per cent.

The calendar today is fairly light otherwise. We get New Zealand GDP this morning, European PMIs this evening and then for the UK, retail sales. US data includes jobless claims, existing home sales, house prices and the Philly Fed index. Apparently HSBC’s China PMI is also due and while it can move markets, it is of limited economic use.

Adam Carr is a leading market economist. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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